Things are Different at the Government

Everyone graduating from law school these days must take a course in legal ethics aka professional responsibility.  State bars also require persons seeking admittance to take a standardized test designed to ensure that those entering the profession have the requisite knowledge of the ethical rules that govern legal practice. 

In 2007 when I was retiring from the Office of Chief Counsel, IRS and beginning to teach at Villanova, the law school wanted me to become a member of the Pennsylvania bar.  Thankfully, Pennsylvania allowed members of the Virginia bar with the requisite number of years of practice to waive into the bar; however, they stopped my application because I had not passed the ethics exam.  I pointed out to them that when I joined the bar in 1977 there was no ethics exam.  I politely inquired if, given my age and length of service, I might be grandfathered in without need to take this standardized test.  The bar examiners politely let me know I needed to take the test.  So, shortly before retiring from federal service, I sat in a room filled with people 30 years younger than me who no doubt wondered what ethical lapses had caused this very old person to take the test.  Thankfully, I passed.

One of the ethical rules, Rule 1.4(2) of the ABA model rules, concerns settlement and the requirement that an attorney must bring a settlement offer to the client.  The ethical rules prevent the attorney from simply rejecting the settlement because the attorney does not like it.  In Delponte v. Commissioner, 158 T.C. No. 7 (2022), the Tax Court explains how that rule does not apply to the attorneys in the Office of Chief Counsel handling an innocent spouse case.  Taking it from the innocent spouse issue to the broader issue of cases handled by Chief Counsel, the rule does not apply to any of the cases in Tax Court nor does it apply to the Department of Justice Tax Division attorneys.  Once a case moves into the office of Chief Counsel or DOJ Tax Division, the attorneys are in the driver’s seat in deciding when to settle.   While they may consult with their client at the IRS, the relationship of the government attorney to its client differs dramatically from the relationship of the attorney in private practice to the client.  This proves unfortunate for Ms. Delponte.

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The case goes back to years from two decades ago.  The Tax Court docket numbers, of which there are five, go back to 2005.  Way back when, Ms. Delponte was married to Mr. Goddard who the Court described as “a lawyer who sold exceptionally aggressive tax-avoidance strategies with his business
partner David Greenberg and became very wealthy in the process.”  Mr. Goddard not only sold aggressive tax shelters, he also invested in them.  The IRS examined his returns, which were joint returns with Ms. Delponte, and proposed huge liabilities.

Ms. Delponte’s involvement in the Tax Court cases provides an interesting procedural sidelight.  The notices of deficiency were sent to Mr. Goddard’s law office years after the parties had split.  Mr. Goddard filed several Tax Court petitions as joint petitions without consulting or notifying Ms. Delponte.  Even though he filed the petitions in years 2005 through 2009, she did not become aware of the petitions until November of 2010.  At that  point she ratified the petitions.  Allowing her to ratify the petitions and be treated as if she timely filed them is an interesting feature of Tax Court jurisdiction.

The Tax Court, and the IRS, would not have known that she did not agree to the filing of the joint petition.  The IRS would have held off making an assessment against her, thinking that doing so would violate IRC 6213.  By putting her name on the petition even without her permission, Mr. Goddard not only suspended the statute of limitations on assessment for her liability but also preserved for her the opportunity to accept or reject the Tax Court case over five years after its filing.  You can see the awkward position this puts everyone in.  Yet, in many ways this works to the unknowing spouse’s advantage since it preserves the right to litigate in a prepayment forum.  The suspension of the statute of limitations on assessment is the downside of this action on the unwitting spouse.

Mr. Goddard not only filed joint petitions but he also listed her as an innocent spouse.  I do not know why in the five years between 2005 and 2010 the case had not progressed to a point that someone at Chief Counsel had pressed on the innocent spouse issue in a Branerton conference or otherwise, but at the point when she came fully into the case nothing seemed to have occurred regarding the innocent spouse defense. 

When you raise an innocent spouse defense in a deficiency case, the Chief Counsel attorneys ask that you complete a Form 8857, the innocent spouse relief form, and they send the form off for review by the innocent spouse unit of the IRS located in Covington, Kentucky.  This finally happened in Ms. Delponte’s case in April of 2011 only six years after the filing of the first petition in the case.

The Court points out that when Chief Counsel refers the case to the innocent spouse unit it requests that the unit not issue a determination letter as it would do if the request had arrived outside of a Tax Court deficiency proceeding but rather that the innocent spouse unit simply provide the results of its review to the attorney handling the deficiency case.  Here the innocent spouse unit reviewed the submission and determined that Ms. Delponte met the criteria for relief.

At the Harvard Tax Clinic we handle quite a few innocent spouse cases.  We submit what we believe are good applications but receive a favorable determination from the innocent spouse unit on a distinct minority of cases.  We usually gain relief from Appeals or from Chief Counsel. So, the fact that this unit granted Ms. Delponte relief in no way reflects that her success at this stage was routine.  Nonetheless, the Chief Counsel attorney did not accept the advice of its client and pressed forward with the innocent spouse case.

So, unlike an attorney in private practice who would be bound by the decision of its client, the government attorney is not so bound.  Ms. Delponte disagreed with the refusal of Chief Counsel to accept the decision made by its client that she met the criteria for relief.  She refused to meet with the Chief Counsel attorney to discuss the case, arguing that the additional information it sought “would be superfluous because CCISO (the innocent spouse unit) had already decided she was entitled to relief and its decision was binding on Chief Counsel.”

Because she would not meet, her innocent spouse status remained unresolved while the deficiency case moved forward, ultimately resulting in a large deficiency determination that was upheld on appeal.  Once the underlying tax issue was complete, the Court turned back to her innocent spouse request. The next post on this case will discuss how the Tax Court came to the conclusion that Chief Counsel’s office could ignore the decision of its client and what happened on the merits of the innocent spouse relief request.

Can Intentionally Filing an Improper Information Return Justify a Claim for Damages Under Section 7434?…Continued!

We welcome back guest blogger Omeed Firouzi, who works as a staff attorney at the Taxpayer Support Clinic at Philadelphia Legal Assistance, for a discussion of the latest case involving an information return with improper information.  The question of how far the statute goes in order to protect recipients continues to play out in the district courts with recipients struggling to gain traction through IRC 7434.  Keith

I, among other tax practitioners, have written on this blog several times about 26 U.S.C. Section 7434. Specifically, we’ve written about the debate in district courts as to whether pure misclassification of an employee as an independent contractor is actionable under Sec. 7434.

A central question in courts’ analysis here is how to interpret the language, “with respect to payments purported to be made to any other person.” § 7434(a). At issue in all these cases, including the one below, is whether willful filing of a fraudulent information return covers only payment amounts themselves or whether it can also encompass misclassification itself.

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On December 1, 2021, the U.S. District Court for the Middle District of Florida, Tampa Division, handed down a decision granting summary judgment in favor of a firm that the plaintiff accused of fraudulent misclassification per Sec. 7434. As such, this court joined the (so far) majority of district courts in ruling that misclassification per se is not actionable under Sec. 7434 (although it was a notable departure from other recent Florida cases).

The case revolves around taxpayer Jen Austin and her experience with Metro Development Group. The case also involved an interesting issue as to whether reimbursed expenses can be included on a Form 1099-NEC and questions of state law. For our purposes though, it is important to look at the relevant 7434 aspect of this case. Austin says she was hired as an employee by Metro in 2014 but then she was actually paid as an independent contractor. Notably, Austin herself formed an LLC (Austin Marketing, LLC) for these 1099 payments though she also alleges she complained several times about her classification to no avail. For his part, the defendant, John Ryan, “testified in his deposition that he did not remember Austin asking to be an employee.” Austin worked for Metro until April 2020; she says she was fired “in a private meeting with Defendant Ryan [but] Ryan claims he never fired her.”

Two months later, Austin and her LLC, Austin Marketing LLC, filed suit against Metro and CEO John Ryan in federal district court. Austin and Austin Marketing, LLC sought, among other claims for relief, damages under Sec. 7434. Though the Court dismissed part of the complaint on the grounds that “Austin was not individually injured by any fraudulent tax standing,” the Court did allow Austin Marketing’s claim to be heard. Ultimately, the defendants moved for summary judgment on the matter of Section 7434, partly “on the basis that misclassification does not give rise to a claim under Sec.7434” – and they won.

In an order written by U.S. District Judge Kathryn Kimball Mizelle, who recently earned national attention with her injunction against the CDC’s federal air and public transit mask mandate order, the Court plainly stated that “only claims for fraudulent amounts of payments may proceed” under Sec. 7434. Judge Mizelle wrote that the plain text of the statute supports this conclusion because “with respect to payments” makes clear that a fraudulent information return must be one that has an incorrect amount on it. Mizelle cites not only U.S. Supreme Court interpretation of the phrase “with respect to,” from an unrelated 2021 case involving the Federal Housing Finance Agency, but also the litany of federal district court cases that also found misclassification per se as outside 7434.

Mizelle also focuses on the next part of the statute, specifically “payments purported to be made.” She writes that the phrase “’payments purported to be made’ clarifies that actionable information returns are ones only where the return fraudulently-that is, inaccurately or misleadingly- reports the amount a payer gave to a payee.” Finally, on this specific matter, Mizelle cites the Liverett case, the Eastern District of Virginia case that most courts have followed to rule misclassification out of bounds of 7434. In citing Liverett, Mizelle argues that because Sec. 7434 defines “information return” as “any statement of the amount of payments [Court’s emphasis added],” the statute thus “only gives liability for” fraudulent payments and “not for any willful filing of an information return instead of a W-2.”

Further, Mizelle also finds that, because Austin herself did not have standing as an individual and because the only case before her now is from Austin Marketing, technically Austin Marketing is not a person to whom W-2s could even be issued. She also finds that the Form 1099s “properly included reimbursements for business expenses” and that “even if the law required exclusion of the reimbursed expenses,” there was no willfulness on the part of the defendants. Mizelle writes that “Austin Marketing’s evidence is…scant [and] amount to mere speculation.”

The Austin case is now one of many, that we have analyzed here, that delve into the frustrating question of whether “fraudulent” describes just payment amounts. Even so, even if one were to take a strictly textualist view of the statute, it is not entirely clear that pure misclassification is not compatible with the statute.

As I have noted here before, even a textual reading of the statute could support the notion that misclassification could give rise to a cause of action under this law. When someone is fraudulently misclassified as a 1099 worker when they should have received a W-2, they receive a form that is, in several ways, different in numbers, format, and details than what is appropriate. Notably here, if a misclassified person was hypothetically reclassified as a W-2 worker, it is possible the taxable gross wages that are reported on line 1 of the W-2 would be different than what their 1099-NEC had shown. That is because of course the taxable wages could exclude some pre-tax deductions whereas it is possible that a 1099 compensation amount wouldn’t account for that. That difference is a difference in amount and if an employer willfully, fraudulently misclassifies as a worker and such a difference is conceivable, the 1099 is arguably also fraudulent in amount.

Further, even if the gross compensation would be the same for a misclassified worker on a 1099 or W-2, the misclassified worker is missing out on federal income tax withholding. As such, the misclassified worker lacks the benefit of such a “payment,” a credit they can use on their tax return where their tax withheld is described by the IRS itself as a “payment.” Therefore, it could credibly be argued that “with respect to payments” could theoretically encompass the “payment” that a federal income tax withholding ultimately is. Judge Mizelle took a strict textualist view to find pure misclassification, when the compensation is not in dispute, to be out of scope for this statute. Another court in the future may take a different view even with the same style of statutory interpretation.

Update on Premature Assessments

At the recent ABA Tax Section meeting the Tax Court announced that it had eliminated its backlog of cases which should stop the premature assessment problem it has created during the past two years because of the significant delays in getting petitioners over to IRS Chief Counsel’s office.  As we have discussed before here and here, when the IRS sends out a notice of deficiency, it puts a time frame on hearing that the taxpayer has filed a petition in Tax Court in response to the notice.  The notice suspends the statute of limitations on assessment for 90 days plus 60 days but the IRS must act relatively quickly after the 90 days runs in order to insure that it makes a timely assessment.  So, if it has not heard that the taxpayer filed a Tax Court petition by the date it selects after sending the notice – something like 90 days plus an additional 20 days – it assesses the liability shown in the statutory notice and begins the collection process.

The Tax Court eventually acknowledged the problem its petition processing delays caused the IRS, and hence the petitioner, and several months ago worked out a system for notifying Chief Counsel of new petitions even before it formally sent the petition to Chief Counsel for answer.  The system seems to have worked well and eliminated or significantly reduced the number of premature assessments.  Judge Toro noted in his comments that because the Tax Court has caught up with its backlog, the Court is winding down the early warning system created to avert premature assessments.  In a later panel Paul Butler, an executive with Chief Counsel in SBSE, stated that petitions generally arrive at Chief Counsel now about 3-4 weeks after filing but some still take a few months. So, it seems that we have a happy ending.

Professor Elizabeth Maresca, the director of the tax clinic at Fordham law school, raised an interesting point at the recent ABA Tax Section meeting that I had not considered.  I pass it along in case others have also not thought of the potential problem caused by the premature assessments and the cases in the settlement pipeline.

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The problem of premature assessments has been around for as long as I remember; however, the incidence of premature assessments prior to the pandemic was low.  In my experience, it usually happened for cases filed around the holiday period at the end of the year when the Tax Court clerk’s office probably operated at a skeletal level due to both holiday leave and end of year use or lose leave.  Each year it seemed some cases would not make it from the Tax Court to Chief Counsel.  For represented petitioners the premature assessment usually caused little problem because their representative would contact the local Chief Counsel office and the assigned attorney would fix the problem rather promptly causing an abatement of the assessment.  For pro se taxpayers who did not know the assessment should not have occurred, fixing the problem did not necessarily occur quickly because they failed to ask for an abatement.  The number of problem cases, however, would generally be quite low which does not mean it did not adversely impact individuals unaware that an easy fix existed.

Now we have quite a large number of premature assessments in the system.  Chief Counsel attorneys are on the alert for premature assessments but may not catch them all.  The possibility exists that the IRS has made premature assessments yet to be reversed and it has collected money on those assessments by offset or otherwise.  Now these cases filed a year or two ago are coming to the end which will cause the preparation of a decision document.  I hope that in every case in which the IRS prepares a decision document, it pulls a transcript and carefully checks to determine if a premature assessment occurred and if payments were made that need to be reflected in the decision document.  I am not sure that it does.

Professor Maresca recommended that attorneys representing petitioners in Tax Court cases request from Counsel a transcript of account for the year(s) before the Tax Court in order to make a check for any premature assessment and payment before signing the decision document.  The advice makes sense to me.  If the taxpayer has made payments on the account and the decision document does not reflect those payments, the taxpayer could lose them unless the problem is found within 30 days of the entry of the decision document.

While I mentioned above that the Chief Counsel assigned to the case will quickly fix it if the premature assessment is brought to their attention, the possibility exists that delays will occur.   Chief Counsel’s office has created a form for making a referral of a premature assessment and has a special email address.  You can find the form here.  The email address is on the form.

If calling your favorite Chief Counsel attorney, or the attorney assigned to the case, or emailing the form does not quickly result in fixing the premature assessment, you could consider filing a Tax Court Rule 55 motion.  Here is a template memorandum that could accompany such a motion for anyone in need of this resource.  Thanks to Frank Agostino for providing this resource.

Hopefully, we will soon be back to the good old days of rare premature assessments.  Until we get all of the assessments from the pandemic worked through the system, be on the lookout for problem cases.

Tax Court Temporarily Stops Issuing Dismissals for Lack of Jurisdiction of Late Deficiency Petitions

This is an update to the post of May 3, 2022, which discussed a May 2, 2022 motion to vacate a dismissal for lack of jurisdiction of a late-filed deficiency case in Hallmark Research Collective, Docket No. 21284-21.  In the motion, Hallmark argued that, after Boechler (a Collection Due Process case), the IRC 6213(a) deadline for filing a deficiency petition also is not jurisdictional and is subject to equitable tolling.  The prior post noted that, a day after the motion was filed, the Chief Judge issued an order directing the IRS to file a response within 30 days (i.e., by June 2).  The update is that on May 10, the Chief Judge assigned the motion to Judge Gustafson for purposes of ruling on the motion.    Motions in cases that had been decided by the Chief Judge are usually assigned to Special Trial Judges for disposition, not currently active Tax Court judges.  So, this unusual assignment shows the Court is taking the motion to vacate very seriously.

Simultaneously, it appears that the Tax Court, unannounced, has stopped issuing orders of dismissal for lack of jurisdiction in late-filed deficiency cases until Judge Gustafson (or, more probably, the Tax Court en banc) rules on the Hallmark motion.

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Research shows that the Tax Court in February and March 2022, combined, dismissed 103 late deficiency petitions for lack of jurisdiction – an average dismissal rate of between 2 and 3 cases a business day.  Yet, the last order of dismissal of a deficiency petition for late filing was entered on Friday, May 6. 

PT will post the IRS response to Hallmark’s motion when that response is filed, though PT expects the IRS will ask for and get a bit more time to file its response, to coordinate its response with the National Office.

One effect of the Tax Court’s suspension of ruling on such motions to dismiss in late-filed deficiency cases is that the Court will thus not, for some time, be creating appealable orders which could be challenged by appeals to the Circuit courts as test cases for the IRC 6213(a) issue.  The time is ticking on any appeals that may be filed concerning orders of dismissal entered between mid-February and May 6.

PT is aware of only one case where an order of dismissal has been appealed:  The February 15, 2022 order of dismissal in Culp, Docket No. 14054-21, was timely appealed to the Third Circuit on April 25, 2022 (3d Cir. Docket No. 22-1789).  In Culp, the IRS sent a notice of deficiency to the taxpayers, but the taxpayers say they never received the notice and only became aware of its possible issuance when the IRS started levying.  (We assume that the Culps also did not receive the notice of intention to levy, since they filed no Collection Due Process hearing request.)  They belatedly filed a Tax Court petition, arguing that the IRS had never sent a notice of deficiency to their last known address.  In response, the IRS produced a copy of the notice and proof of proper mailing to their last known address.  So, the court dismissed the petition for lack of jurisdiction for late filing – the long-standing position of the Tax Court and most courts of appeal, pre-Boechler, being that timely filing of a deficiency petition is a necessary predicate to the Tax Court’s jurisdiction. 

The Center for Taxpayer Rights plans to file an amicus brief in Culp (drafted by the Tax Clinic at the Legal Services at Harvard Law School) that sets forth all the arguments made in the memorandum of law filed to accompany the motion to vacate in the Tax Court Hallmark case for why the Tax Court was wrong to treat timely filing as a jurisdictional requirement of a deficiency suit.

IRS Not Giving Up on Thorny SOL Issues When Taxpayer Fails to Backup Withhold

An issue that is often litigated is whether and when a return is deemed filed for purposes of starting the SOL on assessment. In today’s post, I will discuss Quezada v US and the IRS’s decision to publish an Action on Decision disagreeing with the Fifth Circuit.

We have not discussed AOD’s though we have discussed the Quezada case a few times. The most recent is here, where Keith reviewed how the Fifth Circuit held that the Form 1040 filed by the Quezadas and the Forms 1099 issued by his business to its workers that omitted the workers’ tax identification numbers started the running of the statute of limitations for backup withholding.  As readers may know, the Code requires payers to backup withhold at a rate of 24 percent on reportable payments for a payee that refuses or neglects to provide a correct TIN

An AOD is the Service’s way of notifying the public and its employees about the Office of Chief Counsel’s litigating position. When the IRS loses in a circuit court case, as in Quezada, or a precedential Tax Court opinion, if Counsel disagrees with the opinion, an AOD discusses the reasons why. The AOD lets the public and practitioners know that taking a position consistent with the opinion will lead to the IRS challenging the position if the matter is appealable to a different circuit.

Back to Quezada.

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As Keith discussed, the Fifth Circuit based its holding on the view that the combination of Quezada’s 1040 and the business’ deficient 1099’s provided the IRS with sufficient information to determine potential backup withholding liability:

The court decides that the Forms 1040 and 1099 did provide the IRS with enough information to create an informal Form 945.  The forms filed contained enough data to show he had a backup withholding liability.  The Forms 1099 showed the amount paid and the person paid thus allowing the IRS to calculate the amount of backup withholding that Quezada should have made.  Case over.

The AOD that Counsel issued this past February flatly disagrees with the Fifth Circuit’s discussion of the IRS’s ability to determine backup withholding liability based just on the 1040 and Form 1099:

The omission of a payee’s TIN on a Form 1099-MISC does not conclusively establish the payor’s liability for backup withholding. Instead, backup withholding liability arises from the failure to obtain a payee’s TIN, which is not evident on the face of the Form 1099-MISC. I.R.C. § 3406(a)(1)(A); Treas. Reg. § 31.3406(a)-1(b)(1)(i).

As the AOD notes, if upon making payments to the workers the taxpayer had obtained the workers’ TIN but mistakenly omitted the number, there would be no backup withholding liability. In addition, as the AOD notes, the Service could not determine the extent of the liability just by the taxpayer’s filed 1040 and 1099’s.

As Keith discusses in his post, the Fifth Circuit and IRS disagreed about how to apply the 1944 Supreme Court Lane-Wells opinion.  The AOD does not go so far as arguing for a per se rule that would prevent the SOL from running when there is no return filed for the tax liability at issue, but it takes the view that Form 945 is needed for the SOL to start running on backup withholding liability:

Under Lane-Wells, it is inappropriate to treat a payor’s Form 1099-MISC information returns reporting payments to payees, in combination with the payor’s individual income tax return, as “the return” that triggers the running of the period of limitations for assessing backup withholding liability. This is because: (1) the Forms 1040 and 1099-MISC are separate returns that neither reference nor rely upon each other for either return to be complete; (2) neither the Form 1040 nor the Form 1099-MISC requires reporting backup withholding liability; and (3) the Service has prescribed a separate Form 945 for a payor to report backup withholding liability and that is the form to which it looks in determining whether such liability exists.

Conclusion

The Inspector General has reported taxpayers avoiding payment of billions of dollars in backup withholding. TIGTA noted that IRS was developing a cross-functional working group to analyze current backup withholding policies, so the compliance issue is on IRS’s radar.

Of course the Inspector General’s disclosure two weeks ago revealing that IRS destroyed millions of filed information returns does not atmospherically contribute to liberally allowing IRS to chase taxpayers who themselves make mistakes relating to returns akin to information returns (for that bombshell, see A Service-Wide Strategy Is Needed to Address Challenges Limiting Growth in Business Tax Return Electronic Filing at page 2).

This AOD tells us that IRS is likely to press the issue. Stay tuned.

The 9th Circuit Reverses The Tax Court, Finding That The Taxpayer Had Filed A Return When It Provided A Copy To The IRS During Its Examination

We welcome back guest blogger Janice Feldman. Janice is currently a volunteer attorney at the Harvard Law School Federal Tax Clinic and assisted in drafting the amicus brief filed by the clinic on behalf of the Center for Taxpayer Rights in Seaview Trading, LLC v. Commissioner. Prior to volunteering at the clinic, Janice worked for over 30 years in tax administration, first with the Department of Justice, Tax Division and then with the IRS, Office of Chief Counsel. She retired in 2019. At the time of her retirement, Janice was the Division Counsel/Associate Chief Counsel (National Taxpayer Advocate Program) at the Office of Chief Counsel. Keith 

In Seaview Trading, LLC v. Commissioner, the 9th Circuit looked at the age-old tax question of when is a return considered filed for the purposes of starting the assessment statute of limitations. The Center and the Clinic took a keen interest in this case as this issue – when is a return filed — is central to administering a fair and just tax system. Taxpayers and the IRS, alike, need to know what actions are sufficient to trigger the statute of limitations on assessment. Under the Taxpayer Bill of Rights, taxpayers have a right to finality. IRC Section 7803(a)(3)(F). If the taxpayers’ actions are insufficient to trigger the limitations period, then the IRS can make assessments forever.  

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In Seaview, the taxpayer, a partnership, believed it had filed its 2001 partnership tax return in July 2002, but the IRS had no record of the filing. In 2005, the IRS commenced an audit of the taxpayer’s 2001 return. The IRS agent conducting the exam notified the taxpayer that the IRS had no record of the taxpayer filing a 2001 partnership income tax return (Form 1065) and requested a signed copy. In response, the taxpayer faxed a signed copy of the return to the agent. The IRS later relied on the information on the faxed return to propose an additional assessment against the taxpayer. The final partnership administrative adjustment (FPAA) proposing an assessment was issued in 2010, which was more than four years after the taxpayer faxed a signed copy of the return to the revenue agent.

The Tax Court in TC Memo 2019-122 took a draconian view holding that the taxpayer did not “file” a tax return when it faxed a copy to the IRS agent. Furthermore, the Tax Court found that the 2001 return faxed to the agent did not even qualify as a “return” reasoning that the taxpayer did not intend to file a return when it faxed the return to agent because the taxpayer included a copy of the certified mail receipt showing a July 2002 mailing date. Since the tax return faxed to a revenue officer was not a tax return filing nor a return, the Tax Court found that the final partnership administrative adjustment (FPAA) issued in 2010 was not barred by the limitations period under section 6229(a).  The IRS had unlimited time to assess as no return was filed.   

The taxpayer appealed to the Court of Appeals for the 9th Circuit. On May 11, 2022, the 9th Circuit rendered its decision and reversed the decision of the Tax Court. A copy of the 9th Circuit decision is located here

The Ninth Circuit stated that “Based on the ordinary meaning of “filing,” we hold that a delinquent partnership return is “filed” under § 6229(a) when an IRS official authorized to obtain and process a delinquent return asks a partnership for such a return, the partnership delivers the return to the IRS official in the manner requested, and the IRS official receives the return.”

Since the Tax Court had concluded that the signed copy of the Form 1065 faxed to agent was not a return under the Beard test, See Beard v. Commissioner, 82 T.C. 766, 777 (1984), the 9th Circuit went on to analyze this issue. The 9th Circuit found that the Form 1065 that Seaview faxed to agent met all the Beard criteria and therefore was a return.  

I commend the 9th Circuit. This decision is a big victory for the tax system as the audit process needs to be perceived by taxpayers as fair. When a taxpayer has evinced an honest effort to satisfy his obligation to self-report his tax liability and the IRS relies on that submission as a basis of an examination, the taxpayer should be entitled to finality, and the IRS should not have unlimited time to assess. The receipt of the return by the revenue agent in this situation should start the clock running on the assessment period. The IRS will still have three years from receipt to assess, but the IRS will not have all the time in the world. 

The case was decided in a split decision with a vocal dissent.  The dissenter based her position on the language of the regulation.  The majority acknowledge the regulation but pointed out the places in IRS subregulatory guidance in which the IRS and Chief Counsel instructed employees to accept returns in ways that differed from the rigid requirements of the applicable regulation which required submitting the return to the appropriate IRS Service Center in order for it to start the clock.  Because of the importance of the decision to the system, it will be interesting to see if the IRS accepts the decision and acknowledges that its employees are directed to accept returns in certain circumstances. 

The IRS may decide to limit its acquiescence of this decision to the 9th Circuit and continue to fight this issue in other circuits.  It may decide to seek en banc review encouraged by the dissent or to seek Supreme Court review if it has an adequate conflict.  There will be more to come about this case as the IRS reacts to the decision and plots its path forward.

Court Blesses Offset Before Pandemic When Later Filed Return Would Have Been Treated Differently

In Seto v United States the Court of Federal Claims held that it was permissible to apply a taxpayer’s 2019 federal income tax refund to offset defaulted student loans dating back nearly 30 years. In the case, Seto argued that Treasury unlawfully offset the refund because if he had filed his 2019 return later in the filing season, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) financial relief provisions would have precluded offsets. The case offers a relatively rare judicial consideration of the Treasury Offset Program, and illustrates how some taxpayers who filed returns prior to the pandemic were left worse off than those who filed after Congress and federal agencies administering debts subject to offset provided financial relief.

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The opinion discusses how Seto had approximately $170,000 in student debt, with about $95,000 of that principal, stemming from loans that began in the early 1980’s. The opinion details Soto’s struggles to make payments, leading eventually to a default notice that identified the possibility that any future tax refunds would be applied or offset to the delinquent education debt. In late 2018, the Department of Education informed Soto that it had referred the delinquent debt to the Treasury’s Offset Program, which applies federal payments to differing debts owed to federal and state agencies, including delinquent student loan debt.

In January of 2020, Seto filed his 2019 tax return, and that return reflected an overpayment of $9,228, with almost $8,000 of that due to a claimed Investment Tax Credit for the purchase and installation of a solar energy system.

The IRS processed that return in mid-February 2020, BC (Before COVID).  After the IRS processed the return, it authorized the refund which passed through the IRS filters since Seto had no outstanding federal tax debt.  The refund then moved from the IRS to the Bureau of Fiscal Services for payment which required it go through the TOP filters prior to payment.  Because of the outstanding student loan on the books at TOP, Treasury (aka the Bureau of Fiscal Services) applied the refund to the delinquent student loan debt.

A month or so after, Congress passed CARES. CARES provided taxpayers relief from offsets of CARES payments other than those attributable to delinquent child support. The problem for Seto was that CARES did not go into effect until the President signed the bill into law on March 27, 2020, two months after he filed and about a month after the IRS processed his return.  He also had a problem that the offset by TOP resulted from a regular tax refund and not a CARES economic impact payment.  Nothing in the legislation protected regular tax refunds though neither Seto nor the court focused on this distinction.

Not surprisingly, when Seto heard about the CARES offset relief, he responded by asking for his money back. When that did not happen, he sued, claiming that the offset violated his due process rights. The Court of Federal Claims considered his pro se complaint as an illegal action case, as the due process clause is not money-mandating and thus is generally outside its jurisdiction.

Why was this not a refund suit? From a tax procedure standpoint, when IRS reviews a return and applies an overpayment, no basis exists for a refund suit.  Subsequent to the application, the IRS either applies the refund to a past due federal tax debt or approves the refund for payment causing it to go through the TOP filters where it is applied to the myriad other federal and state debts that qualify for the Treasury Offset Program (for more on this you can check out Keith’s article on offsets here  or an extensive subchapter in Saltzman and Book, IRS Practice & Procedure Chapter 14A.)  The offset to a separate debt after allowance of the refund causes the refund to lose its relationship to the year where the overpayment arose. 

What about when someone is unhappy with the offset? IRC 6402(g) generally insulates Treasury and IRS from legal actions to restrain offsets. 

Despite that protection, the court addressed whether it was appropriate for the offset to occur, especially given that Seto would have been entitled to receive his money if he had simply filed his return two months later.

The IRS processed his return and applied his refund to offset a portion of his outstanding student loan debt on or before February 20, 2020, when Mr. Seto was formally notified of the government’s action. Nothing in the CARES Act states or clearly suggests that the student loan temporarily relief provisions applied retroactively. Absent such statutory language, courts cannot construe laws and implementing regulations to have retroactive effect. Hicks v. Merit Sys. Prof. Bd. ,819 F.3d 1318, 1321 (Fed. Cir. 2016) (“Retroactivity is not favored in the law and congressional enactments and administrative rules will not be construed to have retroactive effect unless their anguage requires this result. Accordingly, we will construe a statute to avoid retroactivity unless there is clear evidence that Congress intended otherwise.”) (cleaned up). Consequently, the enactment of the CARES Act has no bearing on Mr. Seto’s illegal exaction claim.

Conclusion

I have not dug deeply into the file, but the CARES relief provisions the court refers to were directed at Economic Impact Payments and not all claimed overpayments on taxpayers’ 2019 returns.  Barbara Heggie discusses this, and the March 25, 2020 Department of Education’s decision to halt requests for offset, in her April 2020 post Refunds, Offsets & Coronavirus Tax Relief. There are two different offset relief provisions at play and Seto needs the Department of Education relief to protect him and because of the timing of his refund it did not.  So I do not think that CARES has much direct bearing on the legality of the offset, but the Education policy came into effect only two days before then-President Trump signed CARES into law. The opinion notes as well that Seto did receive a couple of thousand dollars of the claimed overpayment due to a processed innocent spouse claim; I suspect that the court means injured spouse, with some of the overpayment likely attributable to Seto’s spouse.

The Mess Following IRS Mistakenly Sending Determination to Taxpayer’s Former Attorney: Missed Deadlines and Damages For Wrongful Disclosure

When the IRS releases a taxpayer’s confidential tax return information to an unauthorized person that taxpayer has a private right of action against the United States for damages. The case of Castillo v US concerns a taxpayer who sought damages after she claimed, and the government admitted, that Appeals improperly sent a CDP notice of determination to an attorney who no longer was authorized to represent her. The IRS’s failure to send the collection determination to the taxpayer’s subsequently hired and authorized new representative led to the taxpayer’s failure to timely challenge the underlying liability in Tax Court, which led to collection action, including a levy on bank accounts and a prohibition on the issuance or renewal of her passport,.

After Ms. Castillo filed a complaint in district court seeking actual damages, punitive damages and attorney’s fees based on the disclosure violation, the government filed a motion for judgment on the pleadings, conceding that its sending of the determination to the old attorney was a violation of Section 6103 but arguing that damages were limited to $1,000, the statutory minimum for violations of Section 6103.

The parties consented for a magistrate judge to resolve the matter, and the court’s order granted the government’s motion with respect to the finding that the government was not on the hook for actual damages but left open for another day the issue of punitive damages and attorney’s fees.

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The case involves a CDP notice issued to the taxpayer after the filing of a notice of federal tax lien.  According to the complaint, the over $80,000 2014 tax debt related to a Brooklyn based seafood store, Castillo Seafood, which Ms. Castillo sold in 2009 and which has had no affiliation with since that time. The taxpayer had been working with an attorney named Molina at the time if the CDP notice’s issuance, and with his assistance and authorization filed a request for a CDP hearing.

The taxpayer retained new counsel prior to the hearing, and that counsel, Elizabeth Maresca and law students of Lincoln Square Legal Services, Inc. (LSLS) communicated with the assigned Appeals Officer at the October 2018 hearing. In addition, the taxpayer and her new counsel had both properly executed and submitted a Power of Attorney. The complaint alleged that the new counsel had confirmed the IRS’ receipt of the new POA and the revocation of the prior POA and that the IRS’s CAF Unit had properly recorded the revocation of the old POA and processing of the new POA.

The government conceded that in December of 2018 it sent the CDP determination to Molina, an attorney no longer authorized to represent the taxpayer. That communication was an unauthorized disclosure of her tax return information under Section 6103. Molina did not forward the CDP determination to Ms. Castillo or to her new representatives.

The case discusses in detail how, by failing to send the determination to Maresca and LSLS, Appeals failed to follow its procedures set out in the IRM. Moreover, the taxpayer alleged in the complaint that the determination supposedly mailed to her was never in fact delivered to her, and postal records two years after the supposed 2018 mailing still indicated that it was “in transit.”

After unsuccessfully trying to get an update on the status of the case, a problem compounded by the late 2018 early 2019 government shutdown,  Maresca only heard about the determination in the fall of 2019, when she and her students ordered transcripts. Upon learning that the determination was issued, Maresca filed a petition in Tax Court challenging the determination and seeking to review the underlying liability. The Tax Court dismissed the petition on jurisdictional grounds finding that even though Ms. Castillo did not receive the notice it was a valid notice because it was properly mailed to her last known address. Ms. Castillo appealed the dismissal to the Second Circuit which suspended the case waiting for the outcome of the Supreme Court decision determining whether late filed petitions raise jurisdictional or claims processing rules.  Now that the Supreme Court has decided the issue and reversed the Tax Court, the Second Circuit will send Ms. Castillo’s case back to the Tax Court which tees up the Boechler issues that Keith has discussed in What Happens After Boechler – Part 4: The IRS Argues That Equitable Tolling Would Not Apply in Deficiency Cases

How Much Can the Taxpayer Recover When There is An Unauthorized Disclosure?

On a separate track, Maresca and LSLS filed a complaint and amended complaint in district court seeking damages for the IRS’s wrongful disclosure.

Section 7431(c) provides that when the government wrongfully discloses tax return information, it is liable for a minimum of $1,000 per violation.  As an alternate to the $1,000 minimum, the statute also provides that a taxpayer is entitled to more than $1,000 per disclosure if actual damages and punitive damages (in the case of a disclosure that is willful or the result of gross negligence) exceed the statutory minimum.

In seeking actual and punitive damages, as well as costs and legal fees, the taxpayer alleged that the sending of the determination to the wrong attorney and the concomitant failure to send the determination to the authorized representative led to her missing her deadline to challenge the liability. That led to collection action. All of that has led to her becoming “emotionally and physically consumed by the effects of the IRS’s error, ”, affecting “her eating habits, her ability to sleep, her blood pressure, and her overall mental health.”

With respect to the actual damages, the government argued that any actual damages did not result from the unauthorized disclosure to the old attorney, but rather related to the failure to send the determination to the proper attorney. According to the government, any harm attributable to the failure to send the determination to the right attorney is itself not specifically addressed in Section 6103 or Section 7431.

The court agreed with the government:

The real problem here is that, at its core, what the Amended Complaint alleges is that [Appeals] neglected to follow IRS procedures and protocols, and, in so doing, made an improper decision as to where to send the Notice of Determination. That decision (which, for this analysis, the Court will label “Event A”) essentially led to two separate events: (1) the unauthorized disclosure of the Notice to Molina (which the Court will label “Event B1”), and (2) the failure to make an authorized disclosure of the Notice to LSLS (which the Court will label “Event B2”).

Events B1 and B2 were arguably two sides of the same coin, resulting simultaneously from the same improper decision. For purposes of Section 7431(c) though, the first level of the proximate-cause inquiry asks what was caused in fact by Event B1 (the unauthorized disclosure that constituted the Section 6103 violation), not what was caused in fact by Event A. The Court simply cannot draw the inference from Plaintiff’s allegations, even taken as true, that Event B1 was itself a “but for” cause of Event B2. In short, although the IRS’s unauthorized disclosure to Molina and its failure to make an authorized disclosure to LSLS both plausibly had the same root cause in the IRS’s failure to follow its own protocols, one cannot be said to have caused the other.

The court noted that the issue would differ if the disclosure to the old counsel led to that unauthorized recipient subsequently disseminating her return information that itself led to harm. Though sympathetic to her plight, the court noted it was “constrained to agree with Defendant that, despite the unfortunate consequences of its conceded failure to send the Notice of Determination to Plaintiff’s authorized representative, Plaintiff has not adequately pleaded that those consequences were caused in fact by the IRS’s disclosure of the Notice to an unauthorized representative.”

Punitive Damages

Despite the victory on actual damages the court did not find in favor of the government on the issue of punitive damages. With respect to the punitive damages issue, there is a split in the circuits as to whether a taxpayer is entitled to punitive damages in the absence of a finding of actual damages.  A Ninth Circuit case from 2004, Siddiqui v US, as well as a handful of district court opinions, have held that that the statute’s use of the word “plus” when referring to the ability to get actual damages and punitive damages introduced ambiguity as to whether punitive damages could be awarded in the absence of actual damages.  Given the principle that waivers of sovereign immunity are to construed in favor of the government those courts held that a finding of no actual damages meant no possibility of punitive damages.

A Fourth Circuit case from the 90’s, Mallas v US, rejected that reading of the statute, and held that so long as there was either a disclosure related to willful or grossly negligent government actions a taxpayer could receive punitive damages. As there was no Second Circuit law on the issue, the court took a crack at its own interpretation, and agreed with Mallas.

In the alternative, the government argued that the allegations did not rise to the level of gross negligence, and even under the Mallas interpretation of the statute the taxpayer was not entitled to punitive damages. The court noted that the standard for gross negligence was substantially higher than ordinary negligence requiring, for example, “conduct that is highly unreasonable and which represents an extreme departure from the standards of ordinary care.”

The court disagreed with the government position that the facts of the case amounted to a relatively “simple albeit continuing error”:

What Plaintiff has pleaded, in her Amended Complaint, is that the IRS repeatedly ignored its own protocols that were intended to assure that its staff paid attention to what the IRS itself deemed “critical” information regarding the identity of the taxpayer’s authorized representative…. This suggests that more than a single, “simple” error, and more than a lack of ordinary care.

With respect to attorney’s fees, the court rejected as preliminary the taxpayer’s argument that the court should award attorney’s fees at this juncture of the case. The damages statute incorporates Section 7430, which requires the taxpayer to prove that she is the “prevailing party”. The means the taxpayer will have to prove that she has “substantially prevailed” with respect to either “the amount in controversy” or “the most significant issue or set of issues presented.” In the absence of a finding on punitive damages, as well as a determination as to whether the government can overcome the presumption that its position was not substantially justified as a result of its failure to follow its own guidance, the court felt that the timing was not right to resolve this issue.

Conclusion

The case continues, and we will watch it carefully. From my discussions with practitioners, it is not uncommon for the IRS to mistakenly send information to former representatives. The thorny interpretative issues in the case are ones that the government and taxpayer are likely to continue to press. The related Boechler issue in this case raise its own issues, albeit arguably connected to the underlying punitive damages claim if in fact the taxpayer does get to have her day in court.